May 19 The Four Tensions Of An Impact Business

Designing a business that can solve a social problem is enormously difficult.

Running any sort of business is hard enough, then you add in the complexity of creating impact and it gets messy.

At least standard businesses have easy ways of measuring success – we either made higher profits or we didn’t.

Impact businesses are more complex, because there comes a point where we forego profit maximisation in order to help someone.

For example, heartless corporations who are obliged to serve shareholders will try and screw over their suppliers, cut benefits for staff, lower the quality of their products to save on costs, lay off employees in order to hit upcoming profit targets, etc.

Because most social enterprises and inclusive businesses aren’t cut-throat, they have to work hard to make sure they’re efficient at all times.

This leads to a dilemma: there are several measures of success, and some of them are conflict.

An increase to one will almost definitely change the rest, and they all have to work in order for the business to succeed.

In my experience, there are four areas that a socially minded business will need to monitor. Getting any three of them right is easy, but the last one will always be difficult.

They are:

Number Of Beneficiaries

Impact On Each Beneficiary

Internal Rate Of Return (IRR)

Realism Of Assumptions

Let’s look at each one in more detail.

Number Of Beneficiaries

How many people do you want to help? What would be an “acceptable” number? This might be determined by gut feel, a legal obligation or by an organisational target.

For the larger projects I work on at B4D, the magic number is generally 1,000 households. Something about that number sounds great, but then again that can be a trivial reason for decision making.

The bigger question is, if the business can only impact 900 households, will we be upset? What are we willing to forego in order to hit the target of 1,000?

Impact On Each Beneficiary

You probably noticed that the number of beneficiaries isn’t particularly impressive without a quantification of how much you can help each beneficiary.

Hypothetically, you could build a business whose aim is to give everyone in Australia a Fantale. Yes, that’s 24 million tiny gifts distributed, and I’d love a Fantale, but it doesn’t make much difference to people’s wellbeing.

Similarly, you could give 24 million people a dollar, but it won’t achieve very much. By contrast, giving 1,000 people in need $24,000 at the right time would be life-changing.

Which idea do you think would attract more support?

This is where it gets murky.

Is your aim to work with more people, or create more impact for each beneficiary?

With your limited resources, where can you have the most impact?

In the example above, would you rather give 24,000 people in need $1,000 each?

Internal Rate Of Return

Your business will need to make a surplus, sometimes known as a profit. Not so that you can buy a Ferrari, but so that it can survive tough times, and so that the organisation can grow larger.

Your surplus is your “Margin of Safety”, so you want to hang onto some retained earnings.

Internal Rate of Return (IRR) is a way of measuring how profitable a business is over several years, factoring in the losses made in the early days.

This tells you about the overall financial health of the organisation.

Usually what happens is an executive sees the IRR and freaks out because it “looks wrong”; Too high and it seems suspicious, too low and it seems unsafe.

It also depends on your industry. If you’re taking more risk, you expect to see more of a return.

Vice versa, a safe industry generally won’t have a huge IRR.

One temptation is to see the IRR, complain that it’s sitting at -4%, and start fiddling with the size of the business. On a spreadsheet, “growth” is surprisingly easy.

The other temptation is to see the IRR sitting at 9%, then start draining cash out of the business so that you can boost the number of beneficiaries or impact. That sounds noble, but it undermines the stability of the organisation.

Realism Of Assumptions

As you’d imagine, attempting to get good numbers for the three categories listed above is tough, so we start making more and more outlandish claims about how successful this business is going to be.

Suddenly we’re growing rapidly, charging more than competitors, running with fewer staff – all so that we can create more impact.

Unfortunately, we have now baked in some dubious assumptions.

For example, how many days do you think your factory will operate per year?

How many orders will each customer make?

How often do you close for stocktake or maintenance?

What happens if your competitors drop their prices?

A business that only works in the best of circumstances is vulnerable.

You could run a great company that helps a lot of people, but then quickly goes bankrupt because one of your guesses was off by 5%.

That’s why we want to build in margins, because they keep us safe and buy us time.

It’s why we build assumptions tables, so that if challenged, we can explain why we picked that number, what makes us confident that it’s realistic, and can explore what happens if we’re wrong.

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Finding Balance

These four factors are often in tension with one another.

You can build something that changes many lives and has realistic assumptions, but no investor will touch it because it loses money.

You can create a business that transforms the lives of a few people, but that might not excite funders.

You might create something that helps a lot of people a little bit, but it will seem trivial and fail to attract enough internal support.

You could develop a business that creates lots of impact for a lot of people, makes good returns, but a slight drop in revenue will knock it over.

That’s why there’s tension. Getting three of them right is easy, but to get all four requires a lot of careful planning, multiple iterations and a tonne of fact-checking.

Picking Your Battles

In my experience, the two you’ll need to fight for are IRR and Realism.

You don’t often need to encourage partners to raise incomes or household numbers. Instead you need to either hose down expectations, or defend the business’s margins.

I will fight for them, because if the business operates for a year, then goes bankrupt, you could argue that there’s been more harm than good for your beneficiaries.

It’s better to build something modest and rugged, than to start large and fragile.